Why Italy's budget plan is so worrying

The populist coalition will not enact prudent reformsâ"and will undo old ones

print-edition iconPrint edition | Leaders

Oct 6th 2018

ITALIANS are frustratedâ"and they are right to be. Because of the financial crisis and chronically low growth they are on average no richer, in real terms, than they were at the turn of the century. Some 10% are out of work; 20% live on less than â¬10,000 ($11,500) a year. In an election in March they voted for change by choosing political outsiders in the form of the Northern League and the Five Star Movement (M5S).

On September 27th a coalition of the two parties unveiled its plan to start the job of lifting the country out of its funkâ"in the form of their first budget. It is both disappointing and worrying. The government makes no attempt to correct Italyâs low productivity growth, without which both the countryâs living standards and its ability to pay down debt cannot sustainably improve. Under previous governments, a lack of reform has held Italy back. This lot go one further by setting out to unpick pensions lawâ"a rare example of a reform that was successfully legislated. The coalition came into office promising a new way of governing. It has fluffed its chance.

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The budget proposes a fiscal deficit of 2.4% of GDP next year (see article). It includes goodies for both governing parties. Luigi Di Maio, leader of M5S, hopes that funding for a basic minimum income, his key pledge, will stem his partyâs fall in opinion polls. The Northern League, led by Matteo Salvini, seems likely to make progress towards its flat tax.

This plan has a number of problems. True, the deficit is narrower than election promises had suggested. Much-needed public investment will grow. But it still breaks euro-zone fiscal rules. It is also higher than Giovanni Tria, the technocratic finance minister, had led investors to expect. That carried an immediate price. By October 2nd the most closely watched government bond yield was 3.4%, its highest since 2014.

Stopping at Eboli

Even before the budget, Italyâs borrowing costs, relative to Germanyâs, were over a percentage point higher than at the election. It will take time for the rise in yields to raise the governmentâs cost of borrowing, which rises only as debt is rolled over. But higher government-bond yields are already translating into higher interest rates for the wider economy. That will counter much of the impact from stimulus, which makes the governmentâs expectations of robust growth next year even more unlikelyâ"and could swell the deficit still further.

The plan is even more striking for the issues that it ducks. Productivity growth is dismal. Money earmarked for public investment often remains unspent, because of a risk-averse bureaucracy. Cumbersome rules and long court cases stifle business. The trade surplus shows that firms exposed to competition are thriving. But the services sector is sheltered. Opening closed professions would help, as would speeding the sale of pub lic assets. Too few Italians work. Italian women are less likely to do so than most of their sisters in the OECD. Employers are loth to hire people because it is so hard to fire them. This is doubly so in the poorer south, where firms pay high wages negotiated at the national level.

The prize to the government that could seize the agenda for reform would be vast. The IMF reckons that simply shifting to company-level, rather than national, wage bargaining could lower unemployment by nearly four percentage points. But that would mean taking on unions, a challenge that successive governments have avoided. Far from showing courage, this government will use the budget to reverse reforms won under a previous administration that raised the retirement age, but which were deeply unpopular.

Without reform, Italyâs exorbitant debt burden of about 130% of GDP will fall slowly at best. Politics could yet push the country nearer default. The budget is a slap in the face for the Euro pean Commission. Yet Italyâs politicians, with an eye on next yearâs European parliamentary elections, may relish the prospect of a Brussels bust-up. Keen to shore up his popularity, Mr Di Maio could call for more spending next year. Investors may not yet be ready to dump Italyâs bondsâ"not least because the European Central Bank will do what it takes to save the euro. But with its extravagance and its refusal to face reality, the government is testing their patience.